Early in the interview, Steve asks Greifeld about Merrin, who has emerged along with Joe Ratterman’s BATS exchange as chief competitors to the dominant electronic exchange.

What follows is our interview with Seth Merrin, conducted to prepare Steve for his interview with Merrin.

Forbes: 2008 was terrible for everyone except for companies that run exchanges (or run like exchanges) like Cantor Fitzgerald, BATS and your company, Liquidnet. What did you see in the market and how does Liquidnet fit in?

Seth Merrin: What we’ve done is we’ve created an institutional market place. You used to be able to go to the floor of the exchange for color on the markets, but most of the volume has left the floor.

70% of all the buy-side assets come through our system. We know what the latent intent of the buy side is. We’ve seen tremendous order flow and imbalances between buys and sells. We understand where the long only are selling, where the hedge are selling.

We’ve seen the largest sell to buy imbalances in our history. We’ve been around for nine years now. Clearly, tremendous selling going on.

We have a tremendous amount of data we can pull.

There is competition in this marketplace. What we’ve done is we have historically, the institutions themselves have pieced out their order flow into the marketplace, which fragments the orderflow tremendously. We’ve re-aggregated all those pieces and have created a marketplace where there wasn’t one before.

Take a look at the Asian markets that have monopolies in whole markets in terms of exchanges. Their markets are down 25% more than European and U.S. markets. If everyone is lining up at one store that obviously creates more demand in that one venue.

We’ve helped out tremendously–we’ve created more opportunities and greater capacity to buy and sell merchandise.

We launched right around 9/11. It was not the best of timing. People were not trading a lot and the assets stopped flowing into the mutual funds and the hedge funds.

The whole ETN (Electronic Trading Network) explosion started happening in 2000. That’s when there were eight ETNs, those were competitors to the exchanges and the regionals were pretty much left out of that.

All of the ETNs consolidated, New York and Nasdaq bought the rest. Everyone thought we were back to a duopoly. They bid up exchange shares to a huge multiple because a duopoly is a great business model.

Internet stocks trades have been around for a long time. Why were institutions so slow to pick up on this?

The Internet itself has really brought a lot of automation to the retail sector but it bypassed the institutional sector. The institutional sector was very manual. Now, for the first time, blocks are traded electronically.

There’s so much money in this industry that efficiency is not always the number one criteria. If we had margins like supermarkets, we would have had automation right away.

How are retail investors affected by this?

Every time they (institutions) try to buy and sell stocks, they move the markets. That comes out of your returns. It’s about a $50 billion a year tax on all of our returns every year. This is a highly inefficient market place. What we’re trying to do is make it an efficient market place. Fifty billion dollars added back is real stimulus. A $50 billion tax refund equals an enormous stimulus package.

How did the recent volatility affect Liquidnet?

It’s good for us. Unlike in a retail play, if you have an account with Schwab you pull up a screen and hit a button. The institutional marketplace is so inefficient. Sometimes liquidity is there, sometimes it’s not. If you miss the liquidity it can cost you dollars per share on a large trade.

Who’s left for Liquidnet to compete with?

Our competition is
Goldman Sachs
, JPMorgan and what’s left of Merrill Lynch.

We offer a quantity discovery mechanism. With an exchange, the average size of a trade is 200 shares and the average order size for an institution is 250,000 shares. That’s a supply-demand imbalance that has to be fixed. Exchanges offer price discovery not quantity discovery. Our average execution size is 54,000 shares.

What about algorithmic trading, that some investors want for secrecy?

The purpose of the algo is to break it up into little tiny pieces to introduce it into a retail market. If they had their druthers, they would rather buy it in one shot.

How does this work?

We have MFS,
Janus
, Schroder Investment Management, all of those guys, not the prop desks of the broker dealers. It loads in all of the intent from all of the clients from around the world.

We match up size with size, if one firm wants to buy a million and another wants to sell half a million, we tell them it’s a match. We don’t tell them how much, we just have them negotiate on price. The total quantity is left out of the picture until they agree on price. They want to negotiate but not divulge too much of their hand.

MFS doesn’t want somebody on the other side knowing it’s MFS so the parties will never know who the counterparty is.

What’s the future for a manual stock exchange like NYSE?

Two forms of market structure are really required: one is a system like ours where trades can happen electronically because there is a buyer and seller. You need capital commitment, which is why there are market makers and specialists to put capital up.

NYSE had greater than 80% market share. But REG NMS [a best-price trade execution rule enacted in 2005] took the moat that circled the NYSE away and they are now down to 40% market share. The market has simply opted away from a manual intermediation to more of an electronic process. Even though Nasdaq billed itself as the “Exchange for the Next 100 Years” it was very manual and intensive. ECNs came along with no human intervention and Nasdaq lost 70% of its market share in a couple of years.

Certainly the floor brokers and specialists are having less to do every single day. Only one market’s left with human intermediaries and that’s the NYSE.

There’s still a lot of vested interests on the floor. Thain bought [Eletronic Trading Firm] Archipelago and said “let the market decide.” Clearly the people are opting for the electronic and not for the human execution.

What about specialists who create an orderly market?

Not with the amount of assets out there–$12 trillion at the beginning of the year, probably $8 trillion now. You can’t expect that a specialist firm has the amount of capital to really create an orderly market.

It’s like when the Fed tries to intervene and buy currency. Ultimately currency and the markets will find its own equilibrium.